Mar 23 2013
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Should I Invest in Stocks or Bonds?

Filed under: Author » Magnum Opus Financial,

What's the Smarter Investment?

Stock Market MonitorIf you have been in the stock market in 2011 then you know how bad things have been. It’s been a terrible massacre. Even though we’re off the lows of the year (1080 on the S&P 500 Index), around 1,200, we are 160 points from the highs of the year. Even when the S&P 500 was at 1360, many stocks were trading at very fair valuation. Valuation is often a good measure as to whether or not the stock market has “gotten out of hand”. When an investor looks at valuation now, many stocks are trading with a single digit P/E (stock price / full year of earnings per share (EPS)).

What About U.S. Treasuries?

Many have rushed into bond mutual funds, bond ETFs, and US Treasuries. While there are several bond funds and ETFs that are worth owning…I have big concerns about US Treasuries.

  1. We don’t have any idea how the US Fiscal Situation will eventually work out.
  2. Interest rates on US Treasuries are near historic lows so you are getting very little bang for your buck. 
  3. With the Federal Funds Rate at zero…there is only up to go for interest rates…which means down for bond prices.

That’s right, bond prices and bond yields (the interest you collect from owning the bond) go in opposite directions. As Treasury prices go through the roof when people flee stocks, bond yields go down dramatically. The opposite is also true. When the Federal Reserve eventually raises rates (and they will) bond yields will rise, destroying the principal investment beyond what the yield will replace in any reasonable amount of time. While US Treasuries have been a terrific investment for about a decade; there is now significant risk from inflation and rising interest rates.

High Yielding Stocks

What do you do to get a 2% yield in this market without running the risk of rising inflation or rising interest rates? Take a look at two great American manufacturers: John Deere (DE) and Caterpillar (CAT). Both stocks have been absolutely obliterated (removing much of the downside risk that comes from owning stocks). CAT traded at $116.55 before the market tumbled. You can now own it for around $81 and change. DE traded for $99.80 and it can now be bought for only $69 and change. Both stocks yield 2.3%, while the 10 year US Treasury yields only 2.169%.

Investment Profile: Caterpillar (CAT)

CAT has been on fire lately (in their business) and their recent acquisition of BUCY means more machines and more parts for them to sell to the users of their equipment. The beauty of the business model for CAT is that many of their machines use 3 times their sales price in parts over the life of the machine. That means great business (and margins) for Caterpillar. There is a ton of work going on in the oil & gas shale formations around the United States and many of these crews are running CAT equipment. Mining around the world for iron ore, coal, copper, gold, rare earths, etc. isn’t going to slow down any time soon. Other places in the world like Australia, South America, and China/Mongolia also have raw materials that need to be pulled out the ground. The bottom line is that the more Caterpillars are rolling around out there, the more parts will be needed to service them.

CAT trades at a P/E of 13.4 with a forward P/E that’s under 10. The company has $14.64 a share in cash on the balance sheet with nearly $1 Billion in free cash flow. Revenue growth is up over 30% on the quarter Year over Year. Earnings are up 40% Year over Year. The fundamental story is intact and the numbers look terrific. Stocks go up in an inflationary environment (as long as it’s not out of control). When bonds go down, it’s usually a result of the money coming out of bonds and into stocks. Investors usually see a choice between one or the other. The yield on the 10 year is less than that on the CAT stock. CAT is very close to it’s 52-wk low, but $36 away from it’s high (giving it plenty of room just to get back to even). Consider owning this stock as a nice alternative to Treasuries.

Investment Profile: John Deere (DE)

Next, John Deere (DE), trades with a P/E of only 11.4 and it also has a forward P/E under 10. Until a stock gets around a 15-16 P/E, we don’t get concerned about valuation as an issue. And, anytime we can get a stock for a single digit P/E, we are more than happy. DE has $8.14/share in cash on the balance sheet with free cash flow of $546 Million. DE also has a 2.3% dividend. The fundamental story of more people, eating more food, is certainly intact. As more people around the world join the middle class in Latin America, China, and other Emerging Asia countries the demand for more food (and more varieties of proteins) continues to increase. This is bullish long term for farm equipment. Also, similar to the Caterpillar story, DE sells parts and service for the machines farmers have already bought. Margins are parts are terrific, but the margins on service are even better.

Dividends over Treasury Yields

So, while US Treasuries have been a great investment for a decade now…interest rates will not stay at zero forever. If it’s a choice between buying a US Treasury with limited to no upside and a 2% interest rate; or a premier American Multinational Manufacturer with a terrific balance sheet and plenty of room over head to run…then I’ll take my chances with CAT or DE. Whether you do to is up to you; but at least you have the facts now to make your decision.

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